Crime and Punishment in the Marketplace: Accountants and Business Executives Repeating History

1. Crime and Punishment in the Marketplace: Accountants and Business Executives Repeating History Alan Reinstein Wayne State University Stephen Moehrle Jennifer Reynolds-Moehrle University of Missouri – St. Louis

2. History of the Paper • CPA Profession 2006 (Moehrle, Previts, Reynolds-Moehrle) • Oversight of CPAs by the individual, the profession, and society • Focuses on economic and societal costs of CPA malfeasance (human capital value, loss of right to practice, fines, loss of freedom) • Alan stresses – there is much more • We agree

3. What Drives Your Decisions and Actions? • Economics • Avoid losing your business reputation and/or license • Avoid paying a big fine • Avoid going to jail • Avoid taking your company down • Ethics • Be viewed as an upstanding member of society • Religion • Be viewed righteously in G-d’s eye • Go to heaven

4. Purpose of This Study • Develop a theme around accounting malfeasance • Reinforce that accountants and business people are not acting rationally regardless of what drives their actions • Hammer this point into our new generation of accountants and business leaders!

5. The Theme in Accounting Malfeasance • One or a few at the top conceive a fraud (or evolve from borderline behaviors to outright fraud) • Often use a complex nexus of deceitful activities • Audit complacency allows the malfeasance to continue • Others comply with requests to carry out the malfeasance or simply allow it to continue

6. What Do They Have to Gain? • Persons at the top – in some cases huge sums of money (But not nearly enough when one examines it more closely) • Auditors – ongoing client fees • Others – often very little

7. What Do They Have to Lose? • Economics: Wealth and Freedom • Ethics: The Value of Their Good Name • Religion: Everything

8. SAS No. 99 Fraud and Moral Triangle Incentive / Pressure ** Attitude/Rationalization Opportunity

9. Cases Summarized to Develop the Theme • Cases from various eras, countries, cultures, and circumstances • Continental Vending Maching Corporation • 1136 Tenants • Equity Funding Corporation of America • ESM Government Securities • Cendant • HIH Insurance

10. Cases Examined (Continued) • Enron • WorldCom • Parmalat • Adelphia • Health South • Alfred Taubman (Sotheby’s)

11. Continental Vending Machine Corporation • Harold Roth owned 25% of Continental and 25% of Valley Commercial (a commercial lender) • From 1956 to 1962, Roth had Valley borrow from Continental and then Roth borrowed from Continental • Financial Statements didn’t reflect the related parties • Continental and Valley did business on the same premises! • Lybrand was auditors / Partners convicted of criminal actions • Roth or auditors could have prevented this

12. 1136 Tenants • Mid 1960’s • Jerome Riker, Real Estate Investor, embezzled $1 million from trust funds his firm managed • Max Rothenberg & Co. was CPA • Auditor detected some suspicious activities • Didn’t follow up • Claimed that he was only hired to perform write-up services • Was found legally culpable • Lost his professional reputation and $230,000 legal judgment

13. Equity Funding Corporation of America • Mid 1960s • Stanley Goldblum, CEO, aggressively seeking acquisitions • Needed to keep stock price up • Ordered the recording of fictitious commissions when earnings shortfalls occurred • Reported deaths on fictitious reinsurance policies to collect on the reinsurance firms death benefits • Scam lasted for several years involving several employees • “It takes a long time and you have to be careful about date stamps and other details. But I had fun being the doctor and giving the guy’s blood pressure and all that” (Co-conspirator with only continuing employment to gain) • Computer programmer wrote a program to generate fake policies

14. ESM Government Securities • ESM officer told audit partner at Alexander Grant that ESM had committed illegal acts and falsified its financial statements • Warned that if you disclose this, Grant would lose a major account • Asked that AG partner work with him to clean things up • Partner got 12 years in prison • Grant paid $175 million in civil suits

15. The Same Theme Just Kept Reappearing • See paper for many more cases from all eras and all cultures • Why do they do this? • Man has been doing it since the start of time • We hope that readers of this paper will NOT! • Build a stronger next generation of professionals

16. Ethics and Business Fraud • Ethical Relativism • Divine Command Theory • Utilitarianism • Deontology • Virtue Ethics

17. Ethical Relativism • No principals are universally valid • All moral principals are valid relative to current tastes • The rules of the society serve as a standard • Weak but nevertheless • All societies forbid and punish the actions

18. Divine Command Theory • Moral standards depend on G-d who is all-knowing • Any act that conforms to the law of G-d is right • An act that breaks G-d’s law is wrong • Christianity, Judaism, Islam, and the other major religions condemn business malfeasance explicitly • We are partial to this theory and believe that no benefits from fraud can offset the costs

19. Utilitarianism • Actions are judged right or wrong solely by their consequences • Right actions are those that produce the greatest balance of happiness over unhappiness • Each person’s happiness is equally important • In business malfeasance a few stand to gain at the expense of many others

20. Deontology • Emphasis is on moral rules and duty • If everyone can’t do a certain action then it is not morally permissable • Emphasizes autonomy, justice, and kind acts • This ethical system prohibits fraud and supports harsh punishment for the fraudulent

21. Virtue Ethics • Morals are internal • This ethical system seeks to produce good people who act well out of spontaneous goodness • Live well • This ethical system condemns business malfeasance by encouraging virtuous behavior by all citizens

22. Religion and Business Fraud • All mainstream religions forbid complicity in malfeasance and promise dire consequences for the non-repentent sinner • Jewish law often states the importance of keeping a good name • The smallest theft or swindle demonstrates a substantial lack of faith in G-d • This more than offsets any ill-gotten gain • This focus on proper conduct resembles the ideal from the opening part of the AICPA’s Code of Professional Conduct: • “A Man Should Be Upright, Not Kept Upright”

23. Religion and Business Ethics • The New Testament draws upon the Old Testament themes • “People who want to get rich fall into temptation and a trap and into many foolish and harmful desires that plunge men into ruin and destruction” • Wealthy people, who often face moral issues, must especially guard their good names

24. Religion and Business Ethics • The Koran stresses that the wealthy man will face G-d’s wrath if he obtained such wealth immorally • If a man attacks the character of an adversary, their efforts will lead to nothing or possibly worse in the next world

25. Conclusion • Man has throughout history been willing to give up his good name for little • Man grossly underestimates the probability of getting caught and the cost of getting caught • Only upon getting caught does man fully reflect upon the actual cost of the action in dollars, damage to themselves, damage to their families and friends, and damage to society

26. Conclusion • What drives your actions? • Economics? • Ethics? • Religion? • Don’t do it! • Believers: • The Attitude / Rationalization component of the famous fraud triangle should be impossible

27. Conclusion • Best internal control for business • Hire Upstanding People